Intangible Assets Give Quintiles IMS a Wide Moat

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Quintiles IMS Q and updating our position on the company to account for the merger between Quintiles, the largest contract research organization, and IMS Health, the dominant player in the healthcare data and analytics space. We believe the combined entity's leading positions in the late-stage contract research, development, and drug commercialization markets make it the go-to partner for biotech and pharma clients and support the firm's upgrade to wide moat and stable ratings. Our post-merger valuation for the firm is $90 per share, up from our $71 per share fair value estimate for Quintiles alone. We believe there is modest upside to the stock, as some investors remain concerned that the large size of the two companies will impede successful integration efforts, or are unconvinced synergies will materialize from the merger.

The company's intangible assets--its proprietary data sets, technology, expertise, and reputation--place Quintiles IMS well ahead of its closest competitors. IMS Health's legacy business compiles healthcare data from over 100,000 sources and consequently, has high fixed acquisition costs, limiting the attractiveness of this market to new entrants. The breadth and scale of this data, along with the firm's reputation for providing accurate and complete data, creates a barrier to entry and allows Quintiles IMS to exhibit substantial pricing power. The firm uses proprietary data adjustments, and clients are likely to stay with IMS to preserve the continuity of the data, which results in high customer retention rates.

We believe Quintiles IMS merits a wide-moat rating. The company's intangible assets place it well ahead of its closest competitors as the go-to partner for drug development and commercialization services. The company benefits from strategic, long-term relationships with biopharma partners and has increasingly entrenched itself in their processes, creating high switching costs. Quintiles IMS' well-diversified client base and behemoth scale solidify its wide-moat rating.

Competitive advantages are strongest in the late-stage CRO market, where the need for global scale limits competition to primarily just the largest CROs like Quintiles IMS. Given the asset-light nature of late-stage CRO businesses, these companies essentially serve as consultants to clinical trial sponsors (pharma/biotech companies). CROs advise and help clients with all aspects of their trials, including planning the size and structure of trials and comparator drugs to use, submitting the trial for regulatory approval, choosing geographic regions and investigators to use, enrolling patients, collecting and analyzing data, and completing applications for regulatory approval. Big Pharma has shifted from outsourcing clinical research on a project-by-project basis to partnering with one or two CROs to handle its entire pipeline. These partnerships have led to longer contracts and bring CROs deeper into sponsors' drug development process, creating stickier customers and higher switching costs. The industry's limited invested capital requirements and need for deep scientific, medical, and regulatory expertise create numerous opportunities for CROs to add value to the drug development process, develop long-term relationship with sponsors, and command premium pricing.

Late-stage CROs' intangible assets--their expertise, data, and reputation for quality and speed--form the foundation of their moat. CROs' extensive data and trial experience allow the firms to position their clients' clinical trials for the highest probability of success. In particular, CROs are privy to a network of physicians and investigators, which are pivotal for the timely trial enrollment. Quintiles IMS, as the largest provider of contract research services in the world, can leverage the data and relationships generated from previous trials to support the clinical trial design and enrollment for its current clients. The firm can also use its unrivaled global patient database to more quickly identify target patient population and evaluate the trade-offs of clinical trial design. Sponsors are willing to pay a premium to increase the chances that their trials will get completed on time and that data will be recorded accurately with all protocols being followed. Given that a significant portion of drug patent lives are devoted to clinical trials, the ability to shave off months from the drug development timeline can translate into millions of dollars in additional revenue. In most competitive therapeutic areas the speed of drug development can be a significant determinant of a drug's ultimate commercial success.

IMS Health's legacy business creates a wide moat in its own right thanks to its proprietary methodologies, reputation, and high switching costs among customers. The segment's data is compiled from over 100,000 sources and consequently has high fixed acquisition costs, limiting the attractiveness of this market to new entrants. At the same time, because of the capital-light nature of the business, the firm can quickly scale its products and expand its clientele with very low marginal costs, leading to high ROICs. The breadth and scale of this data, along with the firm's reputation for providing accurate and complete data, create a barrier to entry and allow Quintiles IMS to exhibit substantial pricing power. Furthermore, the firm uses proprietary methodologies to adjust the data and present it to clients, and clients are likely to stay with IMS to preserve the continuity of this data.

Quintiles IMS has contracts with most large companies in the healthcare sector, which rely on IMS data to develop new products, create annual reports, and inform sales and marketing efforts. This creates high switching costs, since IMS data is so critical to these clients' business processes, and any discrepancies between IMS data and that of another provider could have a negative impact on a company's operations. The IMS brand name is also widely recognized and respected within the healthcare sector, with IMS commonly cited as a reputable, objective source of data in annual reports. The retention rate for IMS' top 1,000 clients is over 99%, and management estimates that the average length of relationships with the firm's top 25 clients is over 25 years.